With rampant corruption, a weak non-oil sector and high unemployment hindering the economy, questions linger over Baghdad’s ability to make the most of the high oil revenues that are pouring in.Published in MEED, 3 March 2014

It is almost 11 years since Saddam Hussein was overthrown by the invading armies of the US and its allies, yet Iraq and its economy remain in a parlous state. Unemployment levels are high and government services and utilities are extremely unreliable in most of the country. To make matters worse, violence and sectarianism have been increasing in recent months.

It is clearly a tough environment in which to do business, as Carlo Sdralevich, a senior economist for the Middle East at the Washington-based IMF, pointed out in March last year.

“Iraq will need to address serious medium-term challenges in order to be able to create the conditions for high and sustainable growth that is necessary to improve the living standards of its people,” he said, following his organisation’s most recent review of Iraq. “The economy continues to suffer from severe structural weaknesses such as a small non-oil sector, high unemployment, public sector dominance and a weak business environment.”

Utilising revenues

Things have not got much better since he made those comments, but there is at least a chance to rebuild the country by using the massive oil revenues that are now pouring into the government’s coffers.

Iraq’s oil output is expected to reach 3.7 million barrels a day (b/d) this year, higher than at any point in the previous 30 years. That in turn has fuelled strong growth in the country’s economy. In 2010, GDP grew by 5.9 per cent and then accelerated to 8.4 per cent by 2012 and an estimated 9 per cent last year, according to the IMF. At the same time, inflation has stayed largely under control. From 6 per cent at the end of 2011, it dropped to 3.6 per cent at the end of 2012, mainly because of lower imported food prices, before creeping back up to 5 per cent in 2013.

Over the coming years, as oil production continues to rise, government spending is expected to climb quickly. The IMF forecasts that overall investment will increase from ID129 trillion ($110bn) this year to ID175 trillion by 2018. Capital expenditure will rise even more quickly, from ID43 trillion in 2014 to ID72 trillion four years later.

But there are plenty of reasons to be cautious. Media reports in late February suggested international oil majors were getting increasingly frustrated with the level of bureaucracy in Baghdad, a situation that could lead to ambitions for further production increases having to be scaled back.

“Iraq initially harboured high hopes of ramping up production very quickly, from 2.5 million b/d to 12 million b/d over the course of the decade. With production stuck at about 3-3.5 million b/d, this is all but impossible,” said the UK-listed Investec Bank in a market review issued on 24 February.

There are also question marks over how well the money that does come in might be spent. The oil sector accounts for the vast majority of government revenues and state-owned enterprises employ close to half of the labour force. But while the government may be enjoying an oil windfall it has not been doing so well when it comes to using its income in ways that benefit the wider economy.

Rampant corruption

“The problem is not that there are not enough funds,” says Zaid al-Ali, senior adviser on constitution-building for the Stockholm-based International Institute for Democracy & Electoral Assistance. “The problem is that the funds that are available are either not spent or are stolen. It has always been the way. What money is spent often just disappears. So the problem is not a lack of funds; the problem is oversight [and] corruption in the government.”

Al-Ali, who was a legal adviser to the UN in Iraq from 2005 to 2010, paints a bleak picture of the environment in the country these days and the lack of progress made since 2003.

“The due process requirements and guarantees that are contained in the constitution are completely ignored,” he says. “Corruption is completely out of control. Services are completely non-existent: electricity; healthcare; education. Sectarianism has worsened since 2003. All this is taking place against a backdrop where the government is almost never held accountable for its actions.”

Despite all the difficulties, the lure of oil revenues means many international firms are still willing to work in the country. The oil majors have led the way, and as their investments take effect they are helping to draw in other firms. The UAE-based Arabtec Holding is among the most recent to announce a move into Iraq. On 29 January, the contractor said it will open an office in Baghdad to take advantage of the anticipated growth in construction activity. Hasan Abdullah Ismaik, its CEO, said at the time that it aimed to “capitalise on the significant new business opportunities that are available, particularly in oil and gas and infrastructure”.

Weak exchange

If there is an improvement in the construction sector then local construction firms will also be hoping to benefit, although recent evidence suggests investors remain wary. Most Iraqi contractors listed on the Iraq Stock Exchange saw their share price drop last year, including Al-Nukhba for Construction, Fallujah for Construction Materials, and Iraqi Engineering Works.

Overall, the stock market had a weak performance in 2013. The main market index was relaunched as the ISX 37 index in February last year, but fell from 120.1 points that month to about 113.2 points by the end of December. Since then it has slipped slightly further, to about 112.6 points at the end of January.

The only company to join the exchange last year was mobile telecoms firm Asiacell in February. There were hopes at the time that it might encourage others to follow, but even the two other mobile operators, Zain Iraq and Korek Telecom, that are meant to list their shares as part of their licence conditions have yet to do so. The lack of depth in the market is underlined by the fact that Asiacell accounted for 62 per cent of the trading volume last year.

But more will be needed than international investment and an active stock market if the economy is to perform to its true potential, not least reforms to the country’s banking system.

There are some 50 private banks in the country but most are small. The IMF says two state-owned banks, Rasheed and Rafidain, hold 71 per cent of all deposits between them and continue to make loans to unviable government-related bodies, often to pay for salaries. These two banks, along with the Trade Bank of Iraq, enjoy an almost complete monopoly over government transactions, but they look to be on shaky foundations. The fund has warned that “while Rasheed and Rafidain are very liquid, they are likely not solvent”.

Overall the Iraqi banking system is far smaller than in other countries around the region. Total banking assets are worth about 77 per cent of GDP, compared with a regional average of 130 per cent, and total credit is about 29 per cent of GDP, against 55 per cent for the region as a whole. Excluding all the loans to state-owned enterprises, the amount of credit to the private sector is just 15 per cent of GDP.

“Developing a stronger financial sector will require moving away from the current model in which weak state-owned lenders dominate the sector and enjoy favourable treatment compared with private banks,” said Sdralevich. “A solid banking system that can support growth and employment will require the full financial and operational restructuring of state-owned banks and creating a level playing field for both private and public banks.”

Tackling joblessness

An overhaul of the banking sector could in turn help boost the non-oil economy, which is needed if the country is to have any chance of tackling unemployment. Officially, joblessness was estimated at 11 per cent in 2011, although the actual level is probably far higher, particularly among young Iraqis. The IMF estimates that 2.1 million more people will join the labour force between 2013 and 2018, but jobs growth is running at just 1 per cent a year, which is nowhere near enough.

As with other oil-rich Gulf states, the government is the most important employer. About 40 per cent of the existing workforce is in the state sector and it accounts for half of all new jobs created. The government was forecast to hire about 150,000 of the 300,000 entrants to the jobs market in 2013, with 130,000 taking up jobs in the private sector and the rest left looking for employment. State-sector jobs often involve relatively high salaries and low levels of work, and this situation is no more sustainable in Iraq than it is anywhere else.

Perhaps more than anything, Iraq also needs to come to a consensus on how power and revenues should be shared between Baghdad and the regions, particularly the Kurdistan Regional Government in the north. A viable solution to this ongoing debate should help create an environment in which the economy can prosper, but it remains up in the air for now.

At least some observers are optimistic that the country will stay intact. “I don’t think Kurdistan will choose independence any time soon, [but] it will always be on the table,” says Ranj Alaaldin, a doctoral researcher at the London School of Economics and Political Science, and visiting scholar at Columbia University in the US. However, he adds, “sectarianism is the most influential and significant of Iraq’s problems”.

As a result, the country’s future remains in the balance. As the oil and gas sector gradually improves, albeit fitfully, the domestic political scene also needs to improve and mature. If not, Iraq could become yet another example of a country where high oil revenues simply lead to a lot of money being wasted.